Mr. Fiat and a Midlife CrisisPerspective on the News
Monday, May 07, 2012Ed DeShields

Fiat currency turned forty-one this year and like most forty-somethings it has its aches and pains. Psychological researchers say you'll face two age-related events that will change your life forever. The first crisis is adolescence and the second is, you guessed it, turning 40.

We’ve never faced a global collapse or an individual collapse of mismanaged currencies. Sure, we’ve had crises in Argentina, Mexico, Russia and in Zimbabwe and elsewhere; but each were local. It’s not uncommon to have a currency crisis. It just hasn’t happened globally before.

At forty, Mr. Fiat doesn’t seem as agile as he once did. His age is showing us clear signs that we’re headed for tough times even though it isn’t clear just how things might work out -- yet.

So what are the signs?

Sovereign debt is exploding globally and there is little that can be done about it. When a government spends money its Gross Domestic Product (GDP) increases. Politicians won’t tolerate a shrinking economy trying to right itself. They won’t be re-elected. They want action so their central bankers open up the spending coffers to force GDP upward. Simultaneously, they demand new taxes to support their spending habit and to care for the poor populace they themselves forced into poverty and unemployment.

Eventually government spending stops lifting the economy as people start to worry about it. People lose their jobs or leave the workplace altogether. The economy shrinks, despite the stimulus of government, in an attempt to balance itself.

Proof of this can be clearly seen as most of Europe falls into various stages of recession to depression. With printing presses running wide open, unemployment rates are reaching 25% in the most troubled countries as political leaders get the boot by angry citizenry. Its central bank is pumping printed money into the banks in an attempt to buffer them if an all-out currency collapse occurs.

Little real wealth is actually created by government when it spends money so, for the most part, it’s not an investment in growing a firm foundation. When countries borrow money by printing it to expand their economies bad things happen. More money floods the system and deflates the value of currency so it buys less (also called inflation).

For example, as of today, for every ounce of gold that you say you have there are thirty-two thousand dollars of true money in circulation. That level of true money is rising at a hyperbolic rate thanks to the Fed’s printing press. Even with low interest rates – in other words, almost no cost of borrowing – the rate at which true money supply is increasing is faster than exponential. That’s frightening.

Countries are now printing money to pay the interest bill on the debt they’ve already created thus creating even more debt. It isn’t going to be long before Mr. Fiat keels over with a massive heart attack.

Making matters worse, countries are artificially lowering interest rates desperately trying to avoid social pain. If rates were high, you’d quickly realize your government is broke as they become unable to make their debt payments or provide social services. Politicians can’t handle that kind of pain.

Need more proof? Look at the bond prices in Europe. Do you really think a 6% yield of Spanish debt is appropriate given its perilous credit status? Its risk rate should be more like 20% because there is a good chance you aren’t going to be repaid.

One day, we won’t be able to keep rates low because people won’t buy their risky debt unless they get much larger returns.

So imagine for a moment where all this might end. It probably won’t be with a single event, but a process that could take longer than we think. It takes a while to re-arrange people’s ideas around money itself.

I predict that we’re actually in that (midlife) process right now unable to stop the sands of time. Let me ask you; have you seen any progress in addressing this issue politically (except blame and condemnation)?

Let’s imagine we’re one of those countries that had experienced a currency crisis. One day we realize we’re facing a collapsing currency. There are no tools for a government to manage this process. You find you’re pretty much on your own as prices rise so fast your grocer is forced to change prices hourly. He decides that he’ll stop selling his goods because he knows he’ll get much more for them tomorrow when he reopens his store.

You could just turn up the printing press. Or, you could follow the Zimbabwe model and just let the thing destroy itself and start over.

But remember we’re talking global here.

You could try to manage it using an established currency like the Euro, dollar or the yen. But what would you have? You’d have rising interest rates (if you can entice investors to participate in your currency with especially attractive returns).

Eventually Mr. Fiat will really have to let the chips fall where they may. He’s going to have to let the market set the price for your money. It won’t be a price anyone will be happy with. We’ll have to live with the consequences. Just like Europe over the next decade.

Oh, yes. A currency discussion cannot occur without the “gold” word. Governments know Mr. Fiat is not feeling well so they’re suddenly starting buying a lot of it. Interesting.

In March 2012 alone, 57.9 tons of gold bullion was purchased by world central banks. That’s up from a rate of 37 tons a month last year. If the current rate of buying by central banks continues at this pace they will purchase a staggering 700 tons of gold bullion in 2012.

Gold demand from central banks does not include the largest central bank buyer: the People’s Bank of China. The Chinese are not reporting their gold-buying numbers to the IMF, but we know they are accumulating a staggering amount of gold bullion to back their currency, the Yuan.

China has a lot of gold. It is trying to set up an alternative settlement system to the dollar that might, or might not be gold backed, but it could help China say to her trading partners in Asia, “my currency, the Yuan, is on more solid ground than the US dollar”. Why don’t you consider accepting my Yuan as the currency of trade?

China might reach the point where they have sufficient gold to trade it on a net basis by using gold credits. Could this tempt the U.S. government to confiscate gold in an attempt to ease its own problem? What would happen to gold price? I bet it would go up quickly and substantially.

Under those assumptions, you are handing China a lot of extra economic power and you’re changing the political landscape of a new global society.

With money printing seemingly the only solution to the world’s economic growth problems, Mr. Fiat is isn’t aging well. He’s not only in a midlife crisis, but he’s not likely to reach his 50’s unless he changes his ways.